U.S. Investing $250 Billion to Bolster Banks; Dow Surges 936 Points

By MARK LANDLER; Reporting was contributed by Eric Dash, Louise Story and Ben White in New York.

Published: October 14, 2008

Buoyed by the biggest intervention in the American banking system since the Depression and similar moves in Europe, stock markets around the world staged one of the most powerful one-day rallies in history on Monday.

The Treasury Department, in its boldest move yet, is expected to announce a plan on Tuesday to invest up to $250 billion in banks, according to officials. The United States is also expected to guarantee new debt issued by banks for three years -- a measure meant to encourage the banks to resume lending to one another and to customers, officials said.

And the Federal Deposit Insurance Corporation will offer an unlimited guarantee on bank deposits in accounts that do not bear interest -- typically those of businesses -- bringing the United States in line with several European countries, which have adopted such blanket guarantees.

The Dow Jones industrial average gained 936 points, or 11 percent, the largest single-day gain in the American stock market since the 1930s. The surge stretched around the globe: in Paris and Frankfurt, stocks had their biggest one-day gains ever, responding to news of similar multibillion-dollar rescue packages by the French and German governments.

Treasury Secretary Henry M. Paulson Jr. outlined the plan to nine of the nation's leading bankers at an afternoon meeting, officials said. He essentially told the participants that they would have to accept government investment for the good of the American financial system.

Of the $250 billion, which will come from the $700 billion bailout approved by Congress, half is to be injected into nine big banks, including Citigroup, Bank of America, Wells Fargo, Goldman Sachs and JPMorgan Chase, officials said. The other half is to go to smaller banks and thrifts. The investments will be structured so that the government can benefit from a rebound in the banks' fortunes.

President Bush plans to announce the measures on Tuesday morning after a harrowing week in which confidence vanished in financial markets as the crisis spread worldwide and government leaders engaged in a desperate search for remedies to the spreading contagion. They are desperately seeking to curb the severity of a recession that has come to appear all but inevitable.

Over the weekend, central banks flooded the system with billions of dollars in liquidity, throwing out the traditional financial playbook in favor of a series of moves that officials hoped would get banks lending again.

European countries -- including Britain, France, Germany and Spain -- announced aggressive plans to guarantee bank debt, take ownership stakes in banks or prop up ailing companies with billions in taxpayer funds.

The Treasury's plan would help the United States catch up to Europe in what has become a footrace between countries to reassure investors that their banks will not default or that other countries will not one-up their rescue plans and, in so doing, siphon off bank deposits or investment capital.

''The Europeans not only provided a blueprint, but forced our hand,'' said Kenneth S. Rogoff, a professor of economics at Harvard and an adviser to John McCain, the Republican presidential candidate. ''We're trying to prevent wholesale carnage in the financial system.''

In the process, Mr. Rogoff and other experts said, the government is remaking the financial landscape in ways that would have been unimaginable a few weeks ago -- taking stakes in the industry and making Washington the ultimate guarantor for banking in the United States.

But the pace of the crisis has driven events, and fissures in places as far-flung as Iceland, which suffered a wholesale collapse of its banks, persuaded officials to act far more decisively than they had previously.

''Over the weekend, I thought it could come out very badly,'' said Simon Johnson, a former chief economist of the International Monetary Fund. ''But we stepped back from the cliff.''

The guarantee on bank debt is similar to one announced by several European countries earlier on Monday, and is meant to unlock the lending market between banks. Banks have curtailed such lending -- considered crucial to the smooth running of the financial system and the broader economy -- because they fear they will not be repaid if a bank borrower runs into trouble.

But officials said they hoped the guarantee on new senior debt would have an even broader effect than an interbank lending guarantee because it should also stimulate lending to businesses.

Another part of the government's remedy is to extend the federal deposit insurance to cover all small-business deposits. Federal regulators recently have been noticing that small-business customers, which tend to carry balances over the federal insurance limits, had been withdrawing their money from weaker banks and moving it to bigger, more stable banks.

Congress had already raised the F.D.I.C.'s deposit insurance limit to $250,000 earlier this month, extending coverage to roughly 68 percent of small-business deposits, according to estimates by Oliver Wyman, a financial services consulting firm. The new rules would cover the remaining 32 percent.